Grocery Stocks: 2 to Buy, 2 to Leave on the Shelf

Picky shoppers will prevail in this low-margin sector

Buy: Safeway

Safeway (SWY) shares have gained more than 12% over the last month amid speculation that the Pleasanton, CA-based chain was a buyout target. The rumors pegged Steve Feinberg’s Cerberus Capital Management as a potential suitor, just weeks after Barry Rosenstein’s Jana Partners LLC disclosed a 6.2% stake in the supermarket chain.

SWY already was streamlining its operations to run leaner and meaner — it sold off its Canadian operations to Empire Co., owner of Nova Scotia-based Sobey’s, for a cool $5.7 billion. Safeway plans to use $2 billion of the sale’s proceeds to pay down debt; it also announced plans to leave the Chicago market by early 2014. Safeway operates 72 Dominick’s stores in the area — the departure will generate a cash benefit of $400 million to $450 million.

Those announcements softened the blow of SWY’s big quarterly earnings miss last month (an EPS of 10 cents instead of the 16-cent profit analysts expected). SWY continues to gain traction with its “Just For U” program, which offers digital coupons based on a shoppers’ buying patterns. The deals can save shoppers 10% to 20% off regular loyalty club pricing.

I think Safeway’s streamlining efforts will be a boon for shareholders and have the potential to boost shareholder value considerably. Even with its recent gains, though, Safeway looks to be valued in line with the sector average — it has a PEG ratio of 1.34 and trades at 20 times forward earnings. The current dividend yield of 2.3% sweetens the deal.